Legal systems around the world apply various strategies to mitigate agency costs between controlling and minority shareholders. In my recent paper, I provide a systematic review of the transnational law on controlling shareholder’s loyalty and care obligations by exploring the cultural, historical, and socio-economic backgrounds embodied in different doctrinal choices.
A. Doctrinal Strategies for Regulating Controlling Shareholder’s Misconduct: A Snapshot
- American law: Ex-ante equitable obligation
Delaware law constrains the potential misbehavior of a controlling shareholder by subjecting him or her to fiduciary obligations. A controlling shareholder holds duties of loyalty and care that require him to act in the best interests of the company and its stockholders. Moreover, transactions involving controlling stockholders are generally subject to the standard of review of entire fairness rather than the default business judgment rule, which prevents second-guessing the board’s judgment (Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983)). Under the entire fairness standard, the controlling shareholder has to establish that the transaction is fair from a commercial perspective (“fair price”), and that it was negotiated, structured and disclosed justly and reasonably (“fair dealing”). However, that burden may shift to plaintiffs if the controlling shareholder can prove that the conflict transaction was approved by a “well-functioning committee of independent directors,” with “no compulsion” to reach an agreement. In the seminal case of Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014), the Delaware Supreme Court adopted a solution that incentivizes the corporation to seek prior approval from both an independent director committee and a majority of minority shareholders. According to this ruling, freezeout transactions will be subjected to deferential business judgment review rather than the entire fairness standard if the merger is structured to include certain procedural safeguards for minority shareholders.
2. English law: Ex-post equitable judicial review
English law does not accept that shareholders should be perceived as fiduciaries and thus refrain from imposing fiduciary duties on controlling shareholder towards minority shareholders or the company. Therefore, controlling shareholders are not compelled by the rigorous duties that the law imposes on directors, such as the duty not to make a profit out of their trust and to avoid all circumstances where their personal interest may differ from the company’s interests. Accordingly, “when a shareholder is voting for or against a particular resolution he is voting as a person owing no fiduciary duty to the company and who is exercising his own right of property, to vote as he thinks fit” (Northern Counties Securities Ltd v Jackson & Steeple Ltd  1 W.L.R 1133, 1144). As a result, the relationship between controlling and minority shareholders are mainly regulated by the ex-post unfair prejudice remedy according to section 994 of the Companies Act of 2006.
3. Civil law: bona fide obligation
Although scholars have argued that civil law countries impose a general duty of loyalty and care on controlling shareholder similar to the position of American law, civil law does not recognize a special concept of a fiduciary. Furthermore, relationships deemed “fiduciary” are governed by a contract or quasi-contractual mechanisms. While the American and civil law may share similar terminology or rhetoric concerning fiduciary duties of corporate organs, there are significant differences in how those obligations are perceived in practice.
B. The Cultural and Socio-Economic Backgrounds of Different Doctrinal Strategies
- Cultural Norms
The fundamental debate regarding the cultural norm that should govern the conduct of the company’s insiders is often characterized as one between those who argue that management should focus primarily on advancing the interests of shareholders and others who support considering the interests of stakeholders. In August of 2019, the Business Roundtable, which includes the CEOs of nearly 200 major U.S. companies, released a statement advancing the stakeholder idea. According to this statement, corporations should protect not only shareholders’ interests, but also those of employees, suppliers, and community members in large.
In principle, we can distinguish between three approaches in comparative corporate governance regarding the corporation’s primary purpose. According to Delaware law, the corporation’s primary purpose is to make profits for shareholders (Dodge v. Ford Motor Co., 170 NW 668, 684 (Mich. 1919)). Thus, management should put shareholders and their returns first, and avoid considering the interests of other corporate constituencies, such as creditors, suppliers, customers, employees, and the communities in which the company operates. United Kingdom law affords considerable protection to stakeholders’ interests by obligating directors to act in good faith to promote the company’s success for the benefit of shareholders. Directors are required to regard several factors when doing this, including the interests of various stakeholders, such as employees and customers (Companies Act 2006, c. 46 § 172(1)). While Enlightened Shareholder Value (ESV) does not embrace stakeholder theory, it certainly does consider their interests as a means to promoting the company’s wellbeing. The civil legal systems have adopted the stakeholder theory, under which the company’s interests are not limited to those of shareholders. They also encompass the interests of creditors, employees, consumers, and society. This is manifested by the German codetermination regime, which reserves up to one-half of the seats on the supervisory board of listed firms to employees and union representatives.
These three views correspond to the scale of loyalty obligations imposed on the controlling shareholder toward the company and his fellow shareholders. Accordingly, the larger the protection provided to shareholders interests in a given legal system, the inclination to assign an equitable fiduciary quality to the loyalty duties of a controlling shareholder is significantly more profound. For instance, since the United States provides rigorous protection to shareholders interests, there is a concern that such protection combined with control devices will be employed by controlling shareholders to unduly deprive private benefit at the expense of minority shareholders and the company. In particular, because shareholder primacy calls for a preference for shareholders’ interests and entrusts them with further decision rights over different business resolutions, broad authority coupled with ownership structures that secure shareholders’ control can impair the minority shareholders and the company’s shareholders interests as a separate legal entity. For example, the United States adopts a permissive approach to dual-class share structures that allows for a “wedge” to be formed between a company’s cashflows and voting rights. To tackle this concern, the American legal system has designed the loyalty obligations under the framework of the fiduciary relationship which subordinate the interests of controlling shareholders to those of the company.
In contrast, the United Kingdom provides some protection to stakeholders’ interests as part of the core obligation of company’s organs to formulate and advance the company wellbeing and shareholder value. Since the cultural norm of the English corporate governance system deviates from providing sole protection to shareholders’ interests, the conduct obligations imposed on controlling shareholders are to some extent less restricting. Therefore, rather than imposing an ex-ante fiduciary obligation on controlling shareholders, English law ensures fairness between shareholders by subjecting controlling shareholders’ conduct to ex-post equitable judicial review. Lastly, the civil law has adopted the stakeholder theory, which identifies the company’s benefit with the aggregate interests of all stakeholders involved in its operation. Since the interests of controlling shareholders are not provided preferable protection in relation to the interests of other constituents, there is no normative justification to subject the relationship between shareholders to the traditional (and far-reaching) common law fiduciary setting.
2. Socio-Economic Background
The doctrinal design of controlling shareholders’ loyalty obligations is also related to the law of business groups (BGs) in various legal systems. The emergence of BGs is related to the immaturity of markets and institutions, which provide established firms with “free cash flow in intra-group capital markets to exploit product-market opportunities.” In the United States, BGs existed as early as the turn of the twentieth century and they became a common corporate form between 1930–1940, mostly in public utilities (e.g., electricity, gas and transportation) and in manufacturing. However, between the 1940s and early 1950s, comprehensive regulation was adopted to eliminate the ownership structure of BGs, as those were perceived to damage the competition in the national economy. Legal reforms in infrastructures, taxation, and protection of investors allowed the removal of concentrated ownership structure and the adoption of a diffuse one. As explained by Kandel et al., 2019, p. 803:
“Until the middle of the 20th century, business groups, often pyramidal in structure, were as important in the United States as they are in present-day emerging markets. Their decline began in the second half of the 1930s and gathered force in the 1940s following a sequence of reforms, explicitly targeting the groups perceived as wielding excessive economic and political influence. We posit that an array of reforms, not a single silver bullet, combined with a long-term shift in U.S. politics, ultimately brought about the demise of U.S. business groups.”
The diminishing prevalence of BGs it the United States is compatible with the current legal arrangements that address the unique agency conflicts in such ownership structures. Consequently, in countries with a particular normative framework for regulating agency conflicts in the BGs setting, there is no need to subject owners to obligations derived from fiduciary law. For instance, several civil law countries regulate the relationship between controlling shareholders and the group’s subsidiaries through a distinctive branch of law termed the law of groups. In contrast, the American legal system has relied on the traditional corporate law’s mechanisms to regulate the relationship between controlling and minority shareholders. Because a particular branch of law devoted to curbing potential misbehavior of controlling shareholder in the context of BGs was non-existent, agency conflicts were generally addressed similarly to independent (one-tier) corporations. Hence, courts in the United States and prominent academic scholars have advanced the idea that powers granted to “any group within the corporation, whether derived from statute or charter or both, are necessarily and at all times exercisable only for the ratable benefit of all the shareholders as their interest appears.” Policymakers were motivated to eliminate the ownership structure of BGs in the United States given its severe consequences for economic growth and competition. Thus, court rulings extended the traditional fiduciary duty imposed on controlling shareholders toward minority shareholders in an independent corporation to majority shareholders of a parent company in its relationship with the minority shareholders of the subsidiary, thereby creating an additional chilling effect to maintaining BGs.
When comparing the state of affairs in the United States to the reality in the United Kingdom, it is not surprising that English law has not adopted the duty of fiduciary to curb the power of controlling shareholders. Since BGs have never been prevalent in the British domestic business, there was no need to address the unique agency conflicts involved in this ownership structure by designing special doctrinal responses. Consequently, English law has long adhered the traditional rule of the common law that controlling shareholders will not be considered as fiduciaries.
C. Policy Implications and Conclusion
In the last two decades, corporate law scholars have debated whether we should expect an apparent convergence of corporate governance norms focusing on maximizing shareholders’ value across different jurisdictions. Moreover, evidence suggests that civil legal systems have adopted large arrangements designed to reinforce the protection afforded to the interests of shareholders following the Anglo-American tradition, such as the recent amendment to the European Directive on the Rights of Shareholders. The macro-level investigation of controlling shareholder’s fiduciary duty has taught us that the doctrinal choices made by different legal systems are very often a result of unique cultural environments and business history changes. This implies that jurists and policymakers should be careful before they adopt doctrinal choices in different parts of corporate governance that will result in the global convergence of legal norms. Additionally, since the design of any corporate governance rule is a product of a unique historical evolutionary process, the automatic implementation of foreign arrangements will not fit with the special socio-economic conditions of a given legal system. Therefore, the initiatives of converging corporate law and governance across nations should be carried out with caution because it can undermine the normative equilibrium embodied in a given jurisdiction.
Dr. Leon Anidjar is an in Incoming Assistant Professor at the IE University School of Law, Madrid
This post is adapted from his paper, “A Macro-Level Investigation of Transatlantic Controlling Shareholder’s Fiduciary Duty,” available on SSRN.